Hedge fund trends 2012 - Joseph Healey

It may be beneficial for financial experts, and for investors and their money managers, to track hedge fund trends regularly. While the up and down nature of the financial market (even the hedge fund market, which promises absolute returns), it can be incredibly useful to analyze trends and attempt to see what will be happening in the future. The issue with trends, of course, is that they come and go, and with sometimes volatile hedge funds, they can do so very quickly. Still, here is a brief look at some of the most recent trends in the hedge fund market, looking specifically at the first quarter of 2012. 

By the nature of tracking trends, we must look back into 2011 to see what has changed – and what has carried over – from then. The most noticeable carry-over is the fact that bigger hedge fund investments seem to be doing the best. Smaller hedge funds are not seeing the same large returns, and in some cases may not be breaking even. Along with the continued asset rising of large funds, one of the trends that are noticeable in the first quarter of 2012 is the fact that hedge funds themselves are increasing. During the first three months of the new year alone, hedge funds increased by an average of over four and a half percent. 

Another trend that experts are keeping their eyes on is the fact that global investing is coming out on top. Emerging markets seem to be the place to invest, now, and it shows no signs of changing any time soon. Global funds saw great advances in assets during the first quarter of 2012 for sure.

Going back to performance in 2011 having an impact on 2012, it seems as though much of the positive performance seen now can be attributed to 2011. Net flow from 2011 that went to large funds made up one hundred and thirty-six percent.

While there have definitely been some “highs” in the trends of 2012 (and 2011), the fact is it wouldn’t be the investment market without a few lows. There have been some significant issues with some major hedge fund players; Paulson & Co has been having difficulty, and fell in 2001 from a summer month thirty-five billion (and change) to around twenty-eight billion in December. Paulson & Co are definitely not the only ones having trouble. 

Overall, the beginning of 2012 looks to be promising. With new capital pouring in to the hedge fund market, and the best performance the market has seen at the beginning of a year since way back in 2006, it seems as though hedge funds may be in for a great year. However, it is always important to keep tracking hedge fund trends, especially the negative ones. The wise investor or fund manager knows better than to trust calm waters for very long; things can, as mentioned before, change very quickly, and a complacent hedge fund is one that will see loss. Typically, hedge funds must be managed aggressively.

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Hedge fund indexes - Healthcor Joe Healey

A hedge fund index reflects the average performance of hedge funds and makes that information available to those who seek it out. It may be investable or non-investable (and, in such cases, purely informative rather than an investment opportunity), and hedge fund indices are quite different depending on which “method” is used to collect and analyze the data. This is a simplistic outline of the different types of hedge fund indices, how they work, and some of the issues that arise with using hedge fund indices in the first place.

First, the question of usability must be brought up. Many people argue that hedge fund indices are unsubstantiated, are prone to bias, and cannot be relied upon. It is true that much of hedge fund index information is self-reported by hedge fund companies, which can lead to a bias. As hedge funds are private investments, there is no central agency to which they must report, and that makes finding hedge funds willing to divulge their returns and performance problematic in many cases. Do not forget that hedge funds are incredibly diverse, as well, and that information on one hedge fund may not remotely resemble information on another. This can make it even more difficult to collate data on hedge fund performance in a cohesive way.

The first form of a hedge fund index is known to be a non-investable index. This type is the one most prone to self-selection bias, as all performance information gleaned from hedge funds was gotten voluntarily. A non-investable index tracks performance in a variety of ways, using mean, median, and weighted mean, and as such, any result from a database search may not match another. Some people still consider it a valuable tool – and any information is better than absolutely no information, in any case.

The second form is the investable index. The main difference is that investment portfolios are created by the index manager, and interested shareholders can invest in the portfolios (as long as they accept all of the terms set forth by the index provider). This creates a functioning investment opportunity, very similar to a hedge fund portfolio in and of itself.

Finally, there is hedge fund replication. This tracks the historical performance of hedge fund returns, and using the data discovered, creates models that illustrate how hedge fund returns will behave under different investment scenarios.This model is also turned into a portfolio that can be invested in. This is the newest of the three forms of hedge fund indices, and because of its newness, there are still questions as to how well this hedge fund replication index method will work in the long term. It is not yet known how accurate hedge fund replication may be in practice.

Despite the drawbacks to using any of the hedge fund indices, there are some definite bonuses. Financial experts (and money managers) are able to study the hedge fund market to better understand how it functions and changes, and can adjust their strategies accordingly.

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What are the regulations regarding hedge funds in other countries besides the U.S.? - Healthcor Joseph Healey

Hedge funds have definitely gone global. While America is one of the “hubs” or financial centers for hedge funds and other types of investments, the international market has seen the lucrative promise of hedge funds, and jumped on board. Additionally, many Americans have seen the benefits of holding offshore hedge funds, and that brings an entirely new dimension to the subject of hedge fund regulation outside of the United States. With so many domestic individuals seeking international hedge funds because of their different laws and regulations, it can complicate matters.

Offshore hedge funds are perhaps the most popular “destination” for this type of investment. There are a few reasons for this; one is that there are no universal requirements for “accredited” investors as there is in the US. Another reason is the structure of offshore hedge funds themselves; they are structured as corporations/companies rather than limited partnerships. What this means for offshore hedge funds is that there is virtually no limit to the number of potential investors, whereas in America, there are strict regulations in place with regards to that. However, there is a “hang up” to Americans investing in offshore hedge funds – they are only legally permitted to do so if they have established offshore life insurance, or established an offshore trust. The popular offshore locations include the Cayman Islands, Dublin, Luxembourg, Bermuda, and more.

Singapore is fairly loosely regulated, especially in comparison to Hong Kong and other Asian financial centers. Smaller funds will continue to be able to operate without licensing even as their regulations and rules change. In Hong Kong, the regulatory structure of hedge funds is very similar to that of mutual funds. In India, the Securities and Exchange Board of India (SEBI) decided to place a ban on any investments made by unregulated companies/entities with participatory notes. 

The European Union is a big center for hedge funds, and they have their own set of rules and regulations. They are not too dissimilar to regulation within the United States, choosing to focus on the regulation of money managers. The FSA (Financial Services Authority) in the United Kingdom requires that fund managers register and become authorized, adhering to the FSA’s regulation. As there are many countries within the European Union, and each has their own set of regulatory laws, having cohesive legislation for the whole EU is difficult. However, with the passing of AIFMD, the EU is one step closer to being able to regulate hedge fund managers all across the board.

However, it should be noted that the Dodd-Frank Act from the US will affect overseas hedge fund investments. Any hedge funds with more than fifteen American investors, and with twenty-five million dollars or more, must register with SEC. Some international funds, especially in Asia, had already registered with the SEC prior to the act, but this act ushers in a whole new era of international hedge fund regulation.

It does seem as though there is a shift internationally to increase regulation on hedge funds, but thus far it has not been overwhelming.

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Are there risks with hedge funds? - joe healey

There are many risks that go along with hedge fund investments. To begin with, hedge funds often deal with large investment amounts, and while profitable returns on those amounts are highly satisfactory, when there is investment loss, it can be significant. Another aspect to keep in mind with hedge fund risks is the fact that they are considered alternative investment products, which are typically known to be high risk. 

Skilled managers do their best to see big returns on the invested money. They may use a variety of methods when managing the hedge fund portfolio -- and this can include leveraging, which is another method that has a steep risk. Leveraging makes investors big profits very quickly, but on the other side of the coin, it can also lead to big losses. Remember that hedge funds are primarily illiquid, unregulated (though the company/money manager must adhere to all trading laws, and the majority of investors must meet specific requirements to open up a hedge fund, the hedge fund itself is not regulated), and may involve hedging against market downturns. While there is often potential to see profitable returns even when the market is unstable, there is still risk.

Another issue with hedge fund risks that should be addressed is transparency. As hedge funds are private investments, the money manager (either a partner or a company/team) is not required in many cases to disclose valuation information, important tax information, and even the underlying investments themselves. Some of this information will be released to the investor, yes – but not always when the investor would find it crucial. The investor may not even know what information is useful to them in determining how the money manager is doing; the money manager is the one with skill and knowledge, and the investor relies on them for their expertise. If the money manager does not disclose information, it may stop the investor from knowing exactly how precarious their investment is. Many investors who would receive the information, and also understand it, may want the manager to make changes, or may consider taking their business elsewhere. The money managers have autonomy to make decisions without much disclosure, and in some cases, this can have negative consequences.

Hedge fund investments can be volatile. There are ups and downs in the vast majority of these investments, and it is up to the money manager to make the majority of decisions without much input from the investor. Putting that much power into a company or a person’s hands comes with its own set of risks; people are not foolproof, not matter how skilled they appear to be. Then you add in how tumultuous the market can be, especially when it comes to commodity trading, global markets, and other unstable situations, all of which are common to hedge fund investments. Investors must trust in the money manager to make aggressive decisions as to the “health” of their hedge fund portfolio, and sometimes the money manager will not deliver satisfactory results. 

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What are the fees associated with hedge funds? - Healthcor Joe Healey

There are several fees associated with hedge funds, but the exact fees that an investor will encounter varies depending on, 1) the money manager they use, and 2) the type of investments they end up making. There are a few fees that are standard to virtually every hedge fund situation, and those are the management and performance fees that are paid out to the hedge fund manager.

Remember that there are usually two people (or a person and a limited liability company) at work together in regards to hedge funds. There is the investor, who provides the money with which investments are made, and then the money manager, who is a skilled, sophisticated professional with specialized experience working with hedge funds. The investor has a “back seat” role, and simply waits for their profits to come in, while the money manager manages the portfolio in a hands-on capacity. The money manager must obviously be compensated for their time and skill. 

The compensation/fees that go to the money manager are, again, the management fee, and the performance fee. The management fee is usually determined annually, and it varies greatly depending on the type of hedge fund portfolio, and the money manager’s level of skill. The management fee is calculated to cover costs of operation, but with bigger and more sophisticated funds, the management fee tends to increase – as the skill level of the money manager should be higher too. The management fee is usually around two percent, but that amount will vary depending on the money manager.

The performance fee is based on profits. Many money managers will require a twenty percent performance fee, although this number will vary. However, a performance fee may not always be a flat, across the board eventuality of hedge funds; if, for example, if a fund fails to make more than its investment (essentially makes no money, or even loses money), there may not be a performance fee paid out. 

There may be something called a high water mark that comes into play when a fund has not made money or has taken loss. This high water mark means that, in many cases, the money manager will not see their incentive (performance) fee until the fund is seeing profit. It is in the money manager’s best interest to make the investor as much profit as they can, as they will see a good deal of their paycheck from profit returns. And no wise investor will stay with a hedge fund portfolio manager that cannot turn a profit on investments!

Another fee that some will encounter in dealing with hedge funds is a withdrawal fee. This may depend on the money manager’s policies; for example, some managers have limits on how much money can be taken out of a hedge fund at once, and will charge a withdrawal fee in order to attempt to curtail frequent withdrawals. 

These are just some of the fees that may be associated with hedge funds. When speaking to a potential hedge fund portfolio manager, enquire as to their specific fees and practices.

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hedge fund joseph healy